ACC223 Module

ACC 223: Basic Accounting
Chapter 1: Accounting and Its Environment
Learning Objectives:
After studying this chapter, you should be able to:
1. Define accounting and explain its role in business.

2. Have a fair knowledge of the evolution of accounting and find how it affected accounting
pedagogy, policy and practice.
3. Describe the fundamental business model and find how it is applied to the various types
of business.
4. Distinguish between the different forms and activities of business organizations.
5. Explain the importance of the purpose and phases of accounting.
6. Ascertain the need to adapt Fra Luca Pacioli’s system for the modern times.
7. Explain the fundamental accounting concepts and principles.
INTRODUCTION
Accounting has evolved, as in the case of medicine and law, in response to the social and
economic needs of society. As business and society become more complex, accounting
develops new concepts and techniques to meet the ever-increasing needs for financial
information. Without such information, many complex economic developments and social
programs may never have been undertaken.
Accounting is relevant in all walks of life and it is absolutely essential in the world of business.
Accounting is the system that measures business activities, processes that information into
reports and communicates the results to decision makers. Accounting quantifies business
communication. For this reason, accounting is called the language of business.
DEFINITION OF ACCOUNTING
Accounting is a service activity. Its function is to provide information, primarily financial in nature,
about economic entities that is intended to be useful in making economic decisions.
Accounting is an information system that measures, processes and communicates financial

information about an economic entity.
Accounting is the process of identifying, measuring and communicating economic information to
permit informed judgements and decisions by users of the information.
Accounting is the art of recording, classifying and summarizing in a significant manner and in
terms of money, transactions and events which are, in part at least, of financial character and
interpreting the results thereof.
EVOLUTION OF ACCOUNTING
Accounting history is the study of the evolution in accounting thought, practices and institutions
in response to changes in the environment and societal needs. It also considers the effect that
this evolution has worked on the environment.
Primitive Accounting
People have counted and kept records throughout history. The origin of keeping accounts has
been traced as far back as 8500 B.C. the date archaeologists have established for certain clay
tokens - cones, disks, spheres and pellets - found in Mesopotamia (modern Iraq).
Accounts records date back to the ancient civilizations of China, Babylonia, Greece and Egypt.
People in these civilizations maintained various types of records of business activities. During
the 1st dynasty of Babylonia (2286-2242 BC.), its law which was based on the Code of
Hammurabi, requires merchants trading goods to give buyers a sealed memorandum containing
the agreed price before it can be considered enforceable. The agreed upon transaction was
recorded by the Scribe on a small mound of clay with the parties affixing “their signatures” on it.
At around 3600 B.C. in Babylonia, clay tablets also recorded payments of wages. The rulers of
these civilizations used accounting to keep track of the costs of labor and materials used in
building structures as in the case of the pharaohs of Egypt in building their great pyramids.
Middle Ages
Development of more formal account-keeping methods is attributed to the merchants and

bankers of Florence, Venice and Genoa during the 13th to 15th centuries.
Double-entry bookkeeping is not a discovery of science; it is the outcome of continued efforts to

meet the changing necessities of trade. German philosopher Oswald Spengler wrote in The
Decline of the West (1928) that the invention of double-entry bookkeeping was the decisive
event in European economic history.
The Florentine Approach
The earliest evidence of business bookkeeping in Florence, France was evidenced by the bank
ledger fragments of 1211 (transcribed in 1887 by Poetro Santini) and with the development of
accounting in Tuscany, Italy during the 13th century, as evidenced in the account-books or
extracts. But, these were within the framework of the “narrative” or “paragraph” type of
accounting record (a sezioni sovrapposte), perhaps derived from the “charge and discharge”
format used in public accounts.
Amatino Manucci was the inventor of double-entry bookkeeping. He managed to construct a

comprehensive and fully-articulated set of double-entry records with a regular balancing
procedure on closure of the General Ledger.
He used five books—general ledger, two merchandise ledgers, expenses ledger, and cash book
(with the white ledger as a sixth)—constituted what looks very like a true double-entry system. In
addition, there were at least two subsidiary books.
The Method of Venice
Luca Pacioli, a Franciscan friar and a celebrated mathematician, is generally associated with
the introduction of double-entry bookkeeping. In 1494 he published his book, Summa de
Arithmetica, Geometria, Proportioni et Proportionalita or “Everything about Arithmetic,
Geometry, Proportions and Proportionality” which includes “Particularis de Computis et
Scripturis” or “Details of Calculation and Recording”, describing double entry bookkeeping.
Although Pacioli made no claim to developing the art of bookkeeping, he has been regarded as
the father of double-entry accounting. He stated that the purpose of bookkeeping was “to
give the trader without delay information as to his assets and liabilities”.
Savary and Napoleonic Commercial Code
The earliest systemized form of accounting regulation developed in continental Europe, starting
in France in 1673. The government introduced the submission of an annual fair value statement
of financial position to protect the economy from bankruptcies.
In the 17th century, Nicolas Petri was the first person to group similar transactions in a separate
record and enter the monthly totals in the journal, rather than recording all transactions seriatim,
that is, in a series.
In 1769, Benjamin Workman published The American Account, the earliest-known American
accounting textbook.
Industrial Revolution, Corporate Organization, Railroads, United States Steel
The expanded business operations initiated by the Industrial Revolution required an increasingly
large amount of funds to build factories and purchase machinery. This need resulted in the
development of the corporate form of organization. The growth of corporations spurred the
development of accounting. Corporate owners, the shareholders, were no longer the managers
of their business. Managers had to create accounting systems to report to the owners the
results of their stewardship of the business. This situation created a need for an independent
report to provide assurance that management’s financial representations are reliable.
Schmalenbach and The Model Chart of Accounts
In the early 1920’s, Professor Schmalenbach was frustrated repeatedly with his failure to
compare meaningfully the financial data made available by different companies. This led to a
research in the problem and the publication of his book, The Model Chart of Accounts. With this
book, he laid the foundation for all subsequent developments in uniform accounting in Germany.
It also became the basis for corresponding efforts in the other European countries.
FUNDAMENTAL BUSINESS MODEL
The business model is built on five activities:
1. First, the investors provide the required capital for the business. The cash investment will
then be held in a bank account.
2. The cash in the business can be:
● converted into another type of asset that will be used in the business or sold
● spent on operating costs such as salaries, rentals and utilities.
3. The combination of business resources provides the basis for producing the products
and services.
4. The sale of a product or service generated an asset called a receivable. This asset once
collected will produce a cash inflow for the business.
5. If there’s an existing debt from banks, the cash inflow from collections will be used to
provide the debt providers with interest on their loans to the company. The rest of the
cash can be sent back to the cycle by being converted into other assets or spent on
operating costs (back to stage 2 ). In the normal course of business, this whole process
will earn profits on which tax will have to be paid. Any profit after tax can continue to be
reinvested on the cycle or paid out to the owners as a “return” on their investment.
To manage a business effectively it is important to know how the cash has been spent and how
profitable the products or services have been to the business. The availability of this historic
information helps management to make judgments on how to improve performance of business.
TYPES OF BUSINESS
Type Activity Structure Examples
Services Selling people’s time Hiring Skilled staff Software

and selling their time development
Accounting, Legal
Trader Buying and selling Buying a range of Wholesaler

products raw materials and Retailer
manufactures goods
and consolidating
them, making them
available for sale in
locations near to their
customers or online
for delivery.
Manufacture Designing products, Taking raw materials Vehicle Assembly

aggregating and using equipment Construction
components and and staff to convert Engineering
assembling finished them into finished Electricity, Water
products goods Food and Drink
Chemicals
Media
Pharmaceuticals
Raw materials Growing or extracting Buying blocks of land Farming

raw materials and using them to Mining
provide raw materials Oil
Infrastructure Selling the utilization Buying and operating Transport (airport,

of infrastructure assets (typically large operator, airlines,
assets); selling trains, ferries, buses)
occupancy often in Hotels
combination with Telecoms
services Sport facilities
Property
Management
Financial Receiving deposits, Accepting cash from Bank

lending and investing depositors and Investment Loans
money paying them interest;
using the money to
provide loans to
borrowers, charging
them fees and a
higher rate of interest
than the depositors
receive
Insurance Pooling premiums of Collecting cash from Insurance

many to meet claims many customers;
of a few investing the money
to pay the losses
experienced by a few
customers. By
understanding the
risk accepted and the
likelihood of a claim,
more premium
income can be
earned than claims
paid.
FORMS OF BUSINESS ORGANIZATIONS
Sole Proprietorship. This business organization has a single owner called the proprietor who
generally is also the manager. This tends to be small service-type business and retail
establishments. The owner receives all profits, absorbs all losses and is solely responsible for
all debts of the business. From an accounting viewpoint, the sole proprietorship is distinct from
its proprietor, thus the accounting records of the business do not include the proprietor’s
personal financial records.
Partnership. A partnership is a business owned and operated by two or more persons who bind
themselves to contribute money, property, or industry to a common fund, with the intention of
dividing the profits among themselves. Each partner is personally liable for any debts incurred
by the partnership. Accounting considers partnership as a separate organization, distinct from
the personal affairs of each partner.
Corporation. A corporation is a business owned by its stockholders. It is an artificial being

created by operation of law, having the rights of succession and the powers, attributes and
properties expressly authorized by law or incident to its existence. The stockholders are not
personally liable for the corporation’s debts. The corporation is a separate legal entity.
MICRO, SMALL AND MEDIUM ENTERPRISES (MSMEs)

On May 23,2008, Republic Act No. 9501 was signed into law by the President Gloria
Macapagal-Arroyo. This law seeks to address problems facing MSMEs, particularly the lack of
capital and access to credit. Under the law, banks and lending institutions are now required to
allocate at least 10% of their total loan portfolio to MSMEs, broken down as follows: 8% to micro
and small enterprises and 2% to medium enterprises.
ACTIVITIES IN BUSINESS ORGANIZATIONS
Financing Activities are the methods an organization used to obtain financial resources from
financial markets and how it manages these resources. Primary sources of financing for most
businesses are owners and creditors such as banks and suppliers.
Investing Activities is to transform resources from one form to a different form, which is more
valuable, to meet the needs of the people. It involves the selection and management including
disposal and replacement of long term resources that will be used to develop, produce and sell
goods and services. Investing activities include buying land, equipment, buildings and other
resources that are needed in the operation of the business and selling these resources when
they are no longer needed.
Operating activities involve the use of resources to design, produce, distribute and market
goods and services. Operating activities include research and development, design and
engineering, purchasing, human resources, production, distribution, marketing and selling and
services.
PURPOSE AND PHASES OF ACCOUNTING
Business transactions are the economic activities of a business. Recording these historical
events is a significant function of accounting. Accounts are produced to aid management in
planning, control and decision making and to comply with regulations.
Before the effects of transactions can be recorded, they must be measured. In order that
accounting information will be useful, it must be expressed in terms of common financial
denominator—money. Money serves as both a medium of exchange and measure of value.
To measure a business transaction, the accountant must decide when the transaction occurred
(recognition issue), what value to place on the transaction (valuation issue) and how the
components of the transaction should be classified (classification issue).
Classification reduces the effects of numerous transactions into useful groups or categories.
Summarization of financial data is achieved through the preparation of financial statements.
These summarize the effects of all business transactions that occurred during some period.
PACIOLI’S DOUBLE ENTRY BOOKKEEPING AND ITS EVOLUTION
In Pacioli’s book, he introduces the double entry accounting system—in which for every debet
dare (should give) there exists a debet habere (should have or should receive).
He discusses three books in the Summa: the memorandum, the journal and the ledger.
In summa, the memorandum is the book where all transactions are recorded, in the currency in
which they are conducted, at the time they are conducted. The memorandum, prepared in
chronological order, is a narrative description of the business’s economic events. The
memorandum is necessary because there are no documents to support transactions.
The second book, the journal, is the merchant’s private book. The entries made here are in one
currency, in chronological order and in narrative form. The last book, known as the ledger, is an
alphabetical listing of all the business’s accounts along with the running balance of each
particular account.
Why has a recording system devised in medieval times lasted so long? There are two main
reasons:
1. It provides an accurate record of what has happened to a business over a specified

period of time; and
2. Information extracted from the system can help the owner of the manager operate the
business much more efficiently.
The system answers three basic questions which the owners wants to know:
● What profit has the business made?

● How much does the business owe?
● How much is owed to it?
Pacioli’s system had to be adapted in the modern business practice so that it can satisfy the
demand for information from two main sources:
1. from owners who want to know from time to time how the business is doing
2. from the managers, who need information in order to help plan and control it.
This results to the development of two main specialization in accounting:
1. Financial accounting which is concerned with the supply of information to the owners of
an entity.
2. Management accounting which is concerned with the supply of information to the
managers of an entity.
FUNDAMENTAL CONCEPTS
Entity Concept - each entity should be evaluated separately
Periodicity Concept - this concept allows the users to obtain timely information to serve as a
basis on making decisions about future activities.
Stable Monetary Unit Concept - The Philippine peso is a reasonable unit of measure and that
its purchasing power is relatively stable.
Going Concern - financial statements are normally prepared on the assumption that the
reporting entity is going concern and will continue in operation for the foreseeable future.
GENERAL ACCEPTANCE OF AN ACCOUNTING PRINCIPLE (GAAP) - encompass

the conventions, rules and procedures necessary to define accepted accounting
practice at a particular time.
The general acceptance of an accounting principle usually depends on how well it meets three
criteria : relevance (results are meaningful and useful), objectivity (results are not influenced or
biased) and feasibility (it can be implemented without complexity).
BASIC PRINCIPLES
Objectivity Principle - accounting records and statements are based on the most reliable data
available so that they will be as accurate and useful as possible.
Historical Cost - This principle states that acquired assets should be recorded at their actual
cost and not what management thinks they are worth as at reporting date.
Revenue Recognition Principle - Revenue is to be recognized in the accounting period when

goods are delivered or services are rendered or performed.
Expense Recognition Principle - Expenses should be recognized in the accounting period in

which goods and services are used up to produce revenue and not when the entity pays for
those goods and services.
Adequate Disclosure - Requires that all relevant information that would affect the user’s
understanding and assessment of the accounting entity be disclosed in the financial statements.
Materiality - Materiality depends on the size and nature of the item judged in the particular
circumstances of its omission.
Consistency Principle - The firms should use the same accounting method from period to period
to achieve comparability over time within a single enterprise.
Discussion Questions:
1. Why is accounting often referred to as the language of business?

2. What are the three forms of business organization? Define each briefly.
3. What are the MSMEs? What purpose does it serve for economic development?
4. What are the types of business? Distinguish them.
5. Give the three definitions of accounting.
6. Why has a recording system, the double-entry, devised in medieval times lasted for so
long?
7. What does the term generally accepted accounting principles mean?
Chapter 2: The Accounting Equation and The Double-Entry System
1. Describe the parts of an information system.

2. Explain how an accounting information system helps the decision makers.
3. Define the elements of financial statements.
4. Describe the accounts (the simple T-account) and its uses.
5. Understand what is meant by the accounting equation and prove the validity of the
:mirror image” concept.
6. Understand what is meant by the double-entry system.
7. Explain how the double-entry system follows the rules of the accounting equation.
8. Define debit and credit.
9. Summarize the rules of debit and credit as applied to balance sheet and income
statement accounts.
10. Describe the nature of the typical account titles used in recording transactions.
11. Analyze and state the effects of business transactions on an entity’s assets, liabilities
and owner’s equity and record these effects on accounting equation form using the
financial transaction worksheet and the T-Accounts
12. Distinguish between revenue and receipts.
PARTS OF AN INFORMATION SYSTEM
An information system is a collection of people, procedures, software, hardware and data which
works together to provide information essential to running an organization
People - are competent end users working to increase their productivity. End users use
hardware and software to solve information-related or decision-making problems.
Procedures - are manuals and guidelines that instruct end users on how to use the software
and hardware.
Software - is another name for programs – instructions that tell the computer how to process
data. There are basically two kinds of software:
System software - is background software that helps a computer manage its internal
resources. An example is the operating system. Windows and Linuz are popular
operating systems.
Application software - performs useful work on general-purpose problems. The two
types of application software are basic applications and advanced applications.
Hardware - consists of input devices, the system unit, secondary storage, output devices, and
communication devices.
Input devices - translate data and programs that humans can understand into a form the
computer can process. The most common are the keyboard, mouse, scanner, digital camera
and microphone.
The System Unit - consists of electronic circuitry with two parts: Central processing Unit
(CPU) which controls and manipulates data to produce information, and Memory (primary
storage) which temporarily holds data, program instructions and processed data.
Secondary Storage - stores data and programs. Three most common storage media are: flash
drive, hard disk and optical disk.
Output Devices- output processed information from the CPU. Two important output devices
are monitor and printer.
Communication Devices - these send and receive data and programs from one computer to
another. A device that connects a microcomputer to a telephone is a modem.
Data - raw material for data processing. Data consists of numbers, letters and symbols and
relates to facts \, events and transactions.
ACCOUNTING INFORMATION SYSTEM
An accounting information system is the combination of personnel, records, and procedures that
a business uses to meet its need for financial information. Most firms have an accounting
manual that specifies the policies and procedures to be followed in accumulating information
within the accounting information system.
An effective accounting information system should achieve the following objectives:

● To process the information efficiently at the least cost (cost benefit principle)
● To protect entity’s assets, to ensure that data are reliable and to minimize wastes and
the possibility of theft or fraud (control principle)
● To be in harmony with the entity’s organizational and human factors (compatibility
principle)
● To be able to accommodate growth in the volume transactions and for organizational
changes (flexibility principle)
TYPES OF ACCOUNTING INFORMATION SYSTEM
Computer-Based Transaction System maintains accounting data separately from other

operating data. It replaces paper records with computer records.
Database systems embed accounting data with business event data on which they are based.
(eg. SAP, Oracle and PeopleSoft).
ELEMENTS OF FINANCIAL STATEMENTS
Element Description or Definition
Asset A present economic resource controlled by the entry as a result of past

events. An economic resource is a right that has the potential to
produce economic benefits.
Liability A present obligation of the entity to transfer an economic resource as a

result of past events.
Equity The residual interest in the assets of the entity after deducting all its
liabilities.
Income Increase in assets, or decreases in liabilities, that result in increase in

equity, other than those relating to contributions from, holders of equity
claims.
Expenses Decrease in assets, or increases in liabilities, that result in decrease in

equity, other than those relating to contributions from, holders of equity
claims.
THE ACCOUNT
The basic summary device of accounting is the account. A separate account is maintained for
each element that appears in the balance sheet (assets, liabilities and equity) and income
statement (income and expense).
ACCOUNT TITLE
Dr Cr
Left Side or Debit Side Right Side or Credit Side
The basic accounting model is:
ASSETS = LIABILITIES + OWNER’S EQUITY

A = L + OE
DEBITS AND CREDITS – THE DOUBLE-ENTRY SYSTEM
The total debits for a transaction must always equal the total credits. An account is debited
when an amount is entered on the left of the account and credited when an amount is entered
on the right side. The abbreviations for debits and credits are Dr. (from the Latin word debere)
and Cr. (from latin credere), respectively.
Increases in assets are recorded as debits while decreases on assets are recorded as credits.
Conversely, increases in liabilities and owner’s equity are recorded as credits and decreases
are entered as debits.
Income and expenses are based on the relationship of these accounts to owner’s equity.
Income increases owner’s equity and expenses decreases owner’s equity. Hence, increases in
income are recorded as credits and decreases as debits. Increases in expenses are recorded
as debits and decreases as credits.
Normal balances in Balance Sheet
ASSET (A)
Increases (+) Decreases (-)
LIABILITIES (L)
Decreases (-) Increases (+)

OWNER’S EQUITY (OE)
Normal balances in Income Statement
EXPENSES (E)
Increases (+) Decreases (-)
INCOME (IN)
The normal balance of any account refers to the side of the account –debit or credit–
where increases are recorded. Assets, owner’s withdrawals and expenses accounts normally
have debit balances; liability, owner’s equity and income accounts normally have credit
balances.
ACCOUNTING EVENTS AND TRANSACTIONS
An accounting event is an economic occurrence that causes changes in an enterprise’s

assets, liabilities and/or equity. Events may be internal or external. A transaction is a particular
kind of event that involves the transfer of something of value between two entities. Examples of
transactions include acquiring assets from owner(s), borrowing funds from creditors and
purchasing or selling goods and services.
Four types of transactions.

1. Source of Assets (SA). An asset account increases and corresponding claims account
increases. Ex. Purchase of supplies on account, or Sold goods on cash on delivery
basis. (IA = IL , IA = IOE)
2. Exchange of Assets (EA). One asset account increases and another asset account
decreases. Ex. Acquired equipment for cash. (IA=DA)
3. Use of Assets (UA). An asset account decreases and a corresponding claims account
decreases. Ex. Settled accounts payable or Paid salaries of employees. (DA = DL , DA =
DOE)
4. Exchange of Claims (EC). One claims account increases and another claims account
decreases. Ex. Received utilities bill but did not pay. (IOE = DL, IL = DL, DOE = IL )
TYPICAL ACCOUNT TITLE USED
Statement of Financial Position (Balance Sheet)
ASSETS
Current Asset - an entity is classified as current assets when:
a. It expects to realize the asset or intends to sell or consume it, in its normal
operating cycle. (Operating cycle is the time between the acquisition of assets for
processing and their realization in cash or cash equivalents. When it is not clearly
identifiable, it is assumed to be twelve months)
b. It holds the asset primarily for the purpose of trading;
c. It expects to realize the asset within twelve months after the reporting period or
d. The asset is cash or cash equivalent unless the asset is restricted from being
exchanged or used to settle a liability for at least twelve months after the
reporting period.
Cash - is any medium of exchange that a bank will accept for deposit at face value. It
includes coins, currency, checks, money orders, bank deposits and drafts.
Cash Equivalent - these are short-term, highly liquid investments that are readily
convertible to known amounts of cash and which are subject to an insignificant risk of
changes in value.
Notes Receivable - is a writing pledge that the customer will pay the business a fixed
amount of money on a certain date.
Accounts Receivable - These are claims against customers arising from sale of
services or goods on credit. This type of receivable offers less security than a promissory
note.
Inventories - these are assets which are (a) held for sale in the ordinary course of
business; (b) in the process of production for such sale; ( c ) in the form of materials or
supplies to be consumed in the production process or in the rendering of services.
Prepaid Expenses - These are expenses paid for by the business in advance, It is an
asset because the business avoids having to pay cash in the future for a specific
expense. These include insurance and rent. These prepaid items represent future
economic benefits–assets–until the time these start to contribute to the earning process;
these, then, become expenses.
Non Current Asset - All other assets should be classified as non-current assets.
Property, Plant, and Equipment. These are tangible assets that are held by an
enterprise for use in the production or supply of goods or services, or for rental to others
or for administrative purposes and which are expected to be used during more than one
period. Included are such items as land, building machinery and equipment, furniture
and fixtures, motor vehicles and equipment.
Accumulated Depreciation. It is a contra account that contains the sum of the periodic
depreciation charges. The balance in this account is deducted from the cost related
asset–equipment or buildings–to obtain book value.
Intangible assets. These are identifiable, nonmonetary assets without physical
substance held for use in the production or supply of goods or services, for rental to
others or for administrative purposes. These include goodwill, patents, copyrights,
licenses, franchises, trademarks, brand names, secret processes, subscription lists and
non-competition agreements.
LIABILITIES
Current Liabilities - an entity shall classify a liability as current when:

● It is expects to settle the liability in its normal operating cycle
● It holds the liability primarily for the purpose of trading
● The liability is due to be settled within twelve months after the reporting
period; or
● The entity does not have an unconditional right to defer settlement of the
liability for at least twelve months after the reporting period.
Accounts Payable - This account represents the reverse relationship of the accounts
receivable. By accepting the goods or services, the buyer agrees to pay for them in the
near future.
Notes Payable - A note payable is like a note receivable but in a reverse sense. In the
case of notes payable, the business entity is the maker of the note; that is, the business
entity is the party who promises to pay the other party a specified amount of money on a
specified future date.
Accrued Liabilities- Amounts owed to others for unpaid expenses. This account
includes salaries payable, utilities payable, interest payable and taxes payable.
Unearned Revenues- When the business entity receives payment before providing its
customer with goods or services, the amount received is recorded in the unearned
revenue account (liability method). When the goods or services are provided to the
customer, the unearned revenue is reduced and income is recognized.
Current Portion of Long-Term Debt - These are portions of mortgage notes, bonds
and other long-term indebtedness which are to be paid within one year from the balance
sheet date.
Non-current Liabilities - all other liabilities

Mortgage Payable - This account records long-term debt of the business entity for
which business entity has pledged certain assets as security to the creditor.
Bonds Payable - The bond is a contract between the issuer and the lender specifying
the terms of repayment and the interest to be charged.
Owner’s Equity
Capital - This account is used to record the original and additional investments of the
owner of the business entity. Iti is increased by the amount of profit earned during the
year or is decreased by a loss. Cash or other assets that the owner may withdraw from
the business ultimately reduce it. This account title bears the name of the owner.
Withdrawals - When the owner of a business entity withdraws cash or other assets
such are recorded in the drawing or withdrawal account rather than directly reducing the
owner’s equity account.
Income Summary - It is a temporary account used at the end of the accounting period
to close income and expenses. This account shows the profit or loss for the period
before closing to the capital account.
INCOME STATEMENT
Income
Service Income - Revenues earned by performing services for a customer or client
Sales - Revenues earned as a result of sale of merchandise.
Expenses
Cost of Sales - The cost incurred to purchase or to produce the products sold to
customers during the period; also called cost of goods sold.
Salaries or Wage Expense - Includes all payments as a result of an
employer-employee relationship such as salaries or wages, 13th month pay, cost of
living allowances and other related benefits.
Telecommunications, Electricity, Fuel and Water Expense - Expenses related to use
of telecommunications facilities, consumption of electricity, fuel and water.
Rent Expense - Expense for space, equipment or other asset rentals.
Supplies Expense - Expense of using supplies in the conduct of daily business.
Insurance Expense - Portion of premiums paid on insurance coverage.
Depreciation Expense - The portion of the cost of tangible assets allocated or charged
as expense during the accounting period.
Uncollectible Account Expense - The amount of receivables estimated to be doubtful
of collection and charged as expense during an accounting period.
Interest Expense - An expense related to use of borrowed funds.
CHAPTER EXERCISES
A. Elements of Financial Statements
1. Using the accounting equation, complete the following table:
ASSET LIABILITIES EQUITY
1 P 457,000 P 270,000
2 P 1,006,000 P 500,000
3 P 309,000 P 120,000
4 P 756,000 P 451,000
5 P 895,000 P 148,000
6 [ 668,000 P 222,000
2. The following figures are extracted from various sole proprietorships. Using the
expanded accounting equation, complete the following table:
ASSET LIABILITIES EQUITY
CAPITAL (+) INCOME (+) EXPENSES (-)
1 P 96,000 P 56,000 P 46,500 P 32,500
2 P 151,000 P 39,000 P 86,000 P 48,000
3 P 182,000 P 65,000 P 37,000 P 25,500
4 P 123,000 P 54,000 P 42,000 P 26,000
5 P 94,000 P 25,000 P 37,000 P 67,500

B. Transaction Effects on the Basic Accounting Model
The following transactions are some of Marciel Supan Services.
Required: For each transaction, indicate whether the assets (A), liabilities (L) or owner’s equity
(OE) increased (+), decreased (-) or did not change (0) by placing the appropriate sign in the
column.
A L OE
a Received cash as additional investment + 0 +
b Purchased supplies on account.
c Charged customers for services made on account
d Rendered services to cash customers.
e Paid cash for rent on the building.
f Collected on account receivable in full
g Paid cash for supplies.
h Returned supplies purchased on account.
i Paid cash to settle accounts.
j Paid cash to owner for personal use.
C. Transaction Analysis
For each transactions for Virginia Ruben Antique Restorer, a sole proprietorship, fill in the
spaces to answer the following questions:
1. What are the two accounts affected by the transaction?
2. What type of account is affected - asset, liability, owner’s equity, owner’s withdrawal,
income or expense account.
3. Should the account increase or decrease?
4. Should the account be debited or credited?
Transactions:
a. Received P 260,000 cash from clients for services rendered.
b. Paid P 480,000 of salaries to employees.
c. Collected P 120,000 from clients on account.
d. The owner, Virginia Ruben, withdrew P 80,000 cash for personal use.
e. Purchased P 140,000 of supplies on account.
f. Billed clients P 180,000 for service rendered.
g. Paid P 100,000 to suppliers on account.
Accounts Affected Type of Account Increase or Debit or Credit

A, L, OE, I, E Decrease
a 1 CASH ASSET INCREASE DEBIT
2 SERVICE INCOME INCOME INCREASE CREDIT
b 1
c 1
d 1
e 1
f 1
g 1
2
Chapter 3: Recording Business Transactions
Learning Objectives;
After studying this chapter, you should be able to;
1. List and explain in brief the sequential steps in the accounting cycle.
2. Identify the general journal as the book of original entry,
3. Detail the standard contents of the general journal.
4. Outline the steps in analyzing transactions and state the role of source documents,
5. Analyze the impact of transactions on the elements and the specific accounts,
6. Apply the rules of debits and credits in analyzing business transactions,
7. Journalize transactions in proper form.
8. Describe a general ledger and understand what purpose it serves
9. Post entries from the general journal to the general ledger
10. 10. Distinguish between permanent and temporary accounts.
11. Develop a chart of accounts.
12. Prepare and explain the use of a trial balance,
13. Perform steps in locating and correcting errors,
TRANSACTION ANALYSIS (Step 1)

The analysis of transactions should follow these four basic steps:
1. Identify the transaction from source documents.
2. Indicate the accounts- either assets, liabilities, equity, income or expenses affected by
the transaction.
3. Ascertain whether each account is increased or decreased by the transaction.
4. Using the rules of debit and credit, determine whether to debit or credit the account to
record its increase or decrease.
ACCOUNTING CYCLE
The accounting cycle refers to a series of sequential steps or procedures performed to
accomplish the accounting process. The steps in the cycle and their aims follow:
During the accounting period:
Step 1 - Identification of Events to be Recorded

Aim: To gather information about transactions or events generally through the source
documents
Step 2 - Transactions are Recorded in the Journal

Aim: To record the economic impact of transactions on the firm in a journal, which is a
form that facilitates transfer to the accounts.
Step 3 - Journal Entries are Posted to the Ledger
Aim: To transfer the information from the journal to the ledger for classification.
At the end of the accounting period
Step 4 - Preparation of a Trial Balance

Aim: To provide a listing to verify the equality of debits and credits in the ledger
Step 5 - Preparation of the Worksheet including Adjusting Entries

Aim: To aid in the preparation of financial statements
Step 6 - Preparation of the Financial Statements

Aim: To provide useful information to decision-makers
Step 7 - Adjusting Journal Entries are Journalized and Posted

Aim: To record the accruals, expiration of deferrals, estimations and other events from
the worksheet.
Step 8 - Closing Journal Entries are Journalized and Posted

Aim: To close temporary accounts and transfer profit to owner's equity
Step 9 -Preparation of a Post-Closing Trial Balance

Aim: To check the equality of debits and credits after the closing entries.
At the start of the next period

Step 10 Reversing Journal Entries are Journalized and Posted
Aim: To simplify the recording of certain regular transactions in the next accounting
period.
This cycle is repeated each accounting period. The first three steps in the accounting cycle are
accomplished during the period. The fourth to the ninth steps generally occur at the end of the
period. The last step is optional and occurs at the beginning of the next period.
THE JOURNAL (step 2)
The journal is a chronological record of the entity's transactions. A journal entry shows all the
effects of a business transaction in terms of debits and credits. Each transaction is initially
recorded in a journal rather than directly in the ledger. A journal is called the book of original
entry. The nature and volume of transactions of the business determine the number and type of
journals needed. The general journal is the simplest journal.
Format
The standard contents of the general journal are as follows:
1. Date. The year and month are not rewritten for every entry unless the year or month
changes or a new page is needed.
2. Account Titles and Explanation. The account to be debited is entered at the extreme left
of the first line while the account to be credited is entered slightly indented on the next
line. A brief description of the transaction is usually made on the line below the credit.
Generally, skip a line after each entry.
3. P. R. (posting reference). This will be used when the entries are posted, that is, until the
amounts are transferred to the related ledger accounts. The posting process will be
described later.
4. Debit. The debit amount for each account is entered in this column.
5. Credit. The credit amount for each account is entered in this column.
Illustration:
Assume that Dr. Rose Besario established her own wedding consultancy with an initial
investment of P250,000 on May 1.
The journal entry is shown below:
Date Account Titles and Explanation PR Debit Credit
1 2020
2 May 1 Cash 250,000
3 Besario, Capital 250,000
4 Initial investment.
Simple and Compound Entry
In a simple entry, only two accounts are affected-one account is debited and the other account
credited. An example of this is the entry to record the initial investment of Besario. However,
some transactions require the use of more than two accounts.
When three or more accounts are required in a journal entry, the entry is referred to as a
compound entry.
TRANSACTIONS ARE JOURNALIZED (Step 2)
After the transaction or event has been identified and measured, it is recorded in the journal.
The process of recording a transaction is called journalizing. The following are the transactions
for Weddings "R" Us during the month of May. The double-entry system will be used.
To understand the nature of the affected accounts, the letter A (for asset), L(liability) or OE
(owner's equity) is inserted after each entry. In addition, owner's equity is further classified into
OE:I (income) and OE:E (expenses).
Note that the rules of double-entry system are observed in each transaction:
1. Two or more accounts are affected by each transaction.
2. The sum of the debits for every transaction equals the sum of the credits.
3. The equality of the accounting equation is always maintained.
Initial Investment (Source of Assets)

May 1 Dr. Rose Besario is a social entrepreneur from the South. She is into a lot of
interesting causes. Her fine taste is preeminent such that she is considered an
authority in planning weddings. She does not intend to "charge much". Upon the
advice and prodding of an esteemed colleague, Dr. Yolanda Sayson, Besario
decided to organize her wedding consultancy. She invested P250,000 into this
entity
Analysis Assets increased. Owner's equity increased.
Rules Increases in assets are recorded by debits. Increases in owner's

equity is recorded by credits.
Entry Increase in assets is recorded by a debit to cash. Increase in the owner's equity
is recorded by a credit to Besario, Capital.
Dr. Cr.
Cash (A) 250,000
BESARIO, Capital (OE) 250,000
Rent Paid in Advance (Exchange of Assets)

May 1 Rented office space and paid two months’ rent in advance, P8,000.
Analysis Assets increased. Assets decreased..
Rules Increases in assets are recorded by debits. Decreases in assets are recorded
by credits.
Entry Increase in assets is recorded by a debit to prepaid rent. Decrease in assets is

recorded by a credit to cash.
Dr. Cr.
Prepaid Rent (A) 8,000
Cash (A) 8,000
Note Issued for Cash (Source of Assets)

May 2 Rose Besario issued a promissory note for a P210,000 loan from Metrobank.
This availment will be used for the acquisition of a service vehicle. The note
carries a 20% interest per annum. The arrangement with the bank is that both
the interest and the principal are payable in full in one year.
Analysis Assets increased. Liabilities increased.
Rules Increases in assets are recorded by debits. Increases in liabilities

are recorded by credits.
Entry Increase in assets is recorded by a debit to cash. Increase in

liabilities is recorded by a credit to notes payable.
Dr. Cr.
Cash (A) 210,000
Notes Payable (L) 210,000
Service Vehicle Acquired for Cash (Exchange of Assets)

May 4 Acquired service vehicle for P420,000.
Analysis Assets increased. Assets decreased.
Rules Increases in assets are recorded by debits. Decreases by credits.
Entry Increase in assets is recorded by a debit to service vehicle. Decrease in assets

is recorded by a credit to cash.
Dr. Cr.
Service Vehicle (A) 420,000
Cash (A) 420,000
Insurance Premiums Paid (Exchange of Assets)

May 4 Paid Prudential Guarantee and Assurance, Inc. P14,400 for a one- year
comprehensive insurance coverage on the service vehicle.
Analysis An asset increased, Another asset decreased.
Rules Increases in assets are recorded by debits. Decreases in assets

Entry Increase in assets is recorded by a debit to prepaid insurance.

Decrease in assets is recorded by a credit to cash.
Dr. Cr.
Prepaid Insurance (A) 14,400
Cash (A) 14,400
Office Equipment Acquired on Account (Exchange and Source of Assets)

May 5 Acquired office equipment from Fair and Square Emporium for P60,000; paying
P15,000 in cash and the balance next month.
Note: A compound entry is needed for this transaction.
Analysis Assets increased. Assets decreased. Liabilities increased.
Rules Increases in assets are recorded by debits. Decreases in assets are recorded
by credits. Increases in liabilities are recorded by credits.
Entry Increase in assets is recorded by a debit to office equipment.
Increase in liabilities is recorded by a credit to accounts payable.
Dr. Cr.
Office Equipment (A) 60,000
Cash (A) 15,000

Accounts Payable (L) 45,000
Supplies Purchased on Account (Source of Assets)

May 8 Purchased supplies on credit for P18,000 from San Jose Merchandising
Analysis Assets.increased. Liabilities increased.
Rules Increases in assets are recorded by debits. Increases in liabilities are recorded
by credits
Entry Increase in assets is recorded by a debit to supplies.

Increase in liabilities is recorded by a credit to accounts payable.
Dr. Cr.
Supplies (A) 18,000
Accounts Payable Partially Settled (Use of Assets)

May 9 Paid San Jose Merchandising P10,000 of the amount owed.
Analysis Assets decreased. Liabilities decreased
Rules Decreases in assets are recorded by credits. Decreases in liabilities are

recorded by debits,
Entry Decrease in liabilities is recorded by a debit to accounts payable,

Dr. Cr.

Cash (A) 10,000
Revenues Earned and Cash Collected (Source of Assets)

May 10 Coordinated and finalized simple bridal arrangements for three couples and
collected fees of P8,800 per couple. Services include prospecting and selecting
the church and reception location, couturier, caterer, car service, flowers,
souvenirs and invitations.
Analysis Assets increased. Owner’s Equity Increase.
Rules Increases in assets are recorded by debits. Increases in owner's equity are
recorded by credits.
Entry Increase in assets is recorded by a debit to cash, Increase in

owner's equity is recorded by a credit to consulting revenues.
Dr. Cr.
Cash (A) 26,400
Consulting Revenue (OE / I) 26,400
Salaries Paid (Use of Assets)

May 13 Paid salaries, P6,600. The entity pays salaries every two Saturdays (refer to the
calendar in Chapter 4).
Analysis Assets decreased, Owner's equity decreased.
Rules Decreases in assets are recorded by credits. Decreases in owner's equity are
recorded by debits.
Entry Decrease in owner's equity is recorded by a debit to salaries expense.

Dr. Cr.
Salaries Expense (OE/E) 6,600
Cash (A) 6,600

Unearned Revenues Collected (Source of Assets)
May 15 The entity is earning additional revenues by referring consulting clients to
friendly hotels, caterers, printers, and couturiers. Received P10,000 advance
fees for three clients referred
Analysis Assets increased. Liabilities increased.
Rules Increases in assets are recorded by debits. Increases in liabilities

Entry Increase in assets is recorded by a debit to cash.

Increase in liabilities is recorded by a credit to unearned referral revenues.
Dr. Cr.
Cash (A) 10,000
Unearned Referral Revenue (L) 10,000

Revenues Earned on Account (Source of Assets)
May 19 Coordinated and finalized elaborate bridal arrangements for three couples and
billed fees of P12,000 per couple. Additional services include documents
preparation, consultation with a feng shui expert as to the ideal wedding date for
prosperity and harmony, provision for limousine service and honeymoon trip.
Analysis Assets increased, Owner's equity increased.
Rules Increases in assets are recorded by debits, Increases in owner's

equity are recorded by credits
Entry Increase in assets is recorded by a debit to accounts receivable,

Increase in owner's equity is recorded by a credit to consulting revenues.
Dr. Cr.
Accounts Receivable (A) 36,000
Consulting Revenue (OE / I) 36,000
Withdrawal of Cash by Owner (Use of Assets)

May 25 Besario withdrew P14,000 for personal expenses,
Analysis Assets decreased. Owner's equity decreased.
Rules Decreases in assets are recorded by credits, Decreases in owner's equity are
recorded by debits.
Entry Decrease in owner's equity is recorded by a debit to Besario Withdrawals.

Dr. Cr.
Besario Withdrawal (OE) 14,000
Cash (A) 14,000
Salaries Paid (Use of Assets)

May 27 Paid salaries, P7,200
Rules Decreases in assets are recorded by credits. Decreases in owner's

equity are recorded by debits
Entry Decrease in owner's equity is recorded by a debit to salaries

expense. Decrease in assets is recorded by a credit to cash
Dr. Cr.
Salaries Expense (OE / E) 7,200
Cash (A) 7,200
Expenses Incurred but Unpaid (Exchange of Claims)

May 30 Received the ICC-BayanTel telephone bill, P1,400,
Analysis Liabilities increased. Owner's equity decreased,
Rules Increases in liabilities are recorded by credits. Decreases in owner's equity are
recorded by debits.
Entry Decrease in owner's equity is recorded by a debit to utilities expense. Increase

in liabilities is recorded by a credit to utilities payable
Dr. Cr.
Utilities Expense (OE / E) 1,400
Utilities Payable (L) 1,400
Accounts Receivable Partially Collected (Exchange of Assets)

May 30 Received P24,000 from two clients for services billed last May 19.
Analysis An asset increased. Another asset decreased,
Rules Increases in assets are recorded by debits. Decreases as credits.
Entry Increase in assets is recorded by a debit to cash, Decrease in assets is recorded

by a credit to accounts receivable.
Dr. Cr.
Cash (A) 24,000
Expenses Incurred and Paid (Use of Assets)

May 31 Settled the electricity bill of P3,000 for the month.
Rules Decreases in assets are recorded by credits. Decreases in owner's equity are
recorded by debits.
Entry Decrease in owner's equity is recorded by a debit to utilities expense. Decrease

in assets is recorded by a credit to cash
Dr. Cr.
Utilities Expense (OE / E) 3,000
Cash (A) 3,000

THE LEDGER
A grouping of the entity's accounts is referred to as a ledger. Although some firms may use
various ledgers to accumulate certain detailed information, all firms have a general ledger. A
general ledger is the "reference book" of the accounting system and is used to classify and
summarize transactions, and to prepare data for basic financial statements.
The accounts in the general ledger are classified into two general groups:
1. balance sheet or permanent accounts (assets, liabilities and owner's equity).
2. income statement or temporary accounts (income and expenses). Temporary or nominal
accounts are used to gather information for a particular accounting period. At the end of the
period, the balances of these accounts are transferred to a permanent owner's equity account.
Each account has its own record in the ledger. Every account in the ledger maintains the basic
format of the T-account but offers more information (e.g. the account number at the upper right
corner and the journal reference column). Compared to a journal, a ledger organizes information
by account.
CHART OF ACCOUNTS
A listing of all the accounts and their account numbers in the ledger is known as the chart of
accounts. The chart is arranged in the financial statement order, that is, assets first, followed by
liabilities, owner's equity, income and expenses. The accounts should be numbered in a flexible
manner to permit indexing and cross-referencing.
When analyzing transactions, the accountant refers to the chart of accounts to identify the
pertinent accounts to be increased or decreased. If an appropriate account title is not listed in
the chart, an additional account may be added.
POSTING (Step 3)
Posting means transferring the amounts from the journal to the appropriate accounts in the
ledger, Debits in the journal are posted as debits in the ledger, and credits in the journal as
credits in the ledger. The steps are illustrated as follows:
1. Transfer the date of the transaction from the journal to the ledger.
2. Transfer the paRe number from the journal to the journal reference (J.R.) column of the
ledger.
3. Post the debit figure from the journal as a debit figure in the ledger and the credit figure
from the journal as a credit figure in the ledger.
4. Enter the account number in the posting reference column of the journal once the figure
has been posted to the ledger.
TRIAL BALANCE (Step 4)
The trial balance is a list of all accounts with their respective debit or credit balances, It is
prepared to verify the equality of debits and credits in the ledger at the end of each accounting
period or at any time the postings are updated. The procedures in the preparation of a trial
balance follow:
1. List the account titles in numerical order.

2. Obtain the account balance of each account from the ledger and enter the debit
balances in the debit column and the credit balances in the credit column.
3. Add the debit and credit columns,
4. Compare the totals.
The trial balance is a control device that helps minimize accounting errors. When the totals are
equal, the trial balance is in balance. This equality provides an interim proof of the accuracy of
the records but it does not signify the absence of errors. For example, if the bookkeeper failed to
record payment of rent, the trial balance columns are equal but in reality, the accounts are
incorrect since rent expense is understated and cash overstated.
The trial balance for the illustration follows;

LOCATING ERRORS
An inequality in the totals of the debits and credits would automatically signal the presence of an
error. These errors include:
1. Error in posting a transaction to the ledger:

● an erroneous amount was posted to the account.
● a debit entry was posted as a credit or vice versa.
● a debit or credit posting was omitted,
2. Error in determining the account balances:

● a balance was incorrectly computed.
● a balance was entered in the wrong balance column.
3. Error in preparing the trial balance;

● one of the columns of the trial balance was incorrectly added.
● the amount of an account balance was incorrectly recorded on the trial balance,
● A debit balance was recorded on the trial balance as a credit or vice versa, or a balance
was omitted entirely.
What is the most efficient approach in locating an error? The following procedures when done in
sequence may save considerable time and effort in locating errors:
1. Prove the addition of the trial balance columns by adding these columns in the opposite
direction.
2. If the error does not lie in addition, determine the exact amount by which the trial balance
is out of balance. The amount of the discrepancy is often a clue to the source of the
error. If the discrepancy is divisible by 9, this suggests either a transposition (reversing
the order of numbers) error or a slide (moving of the decimal point).
For example, assume that the cash account balance is P21,750, but in copying the
balance into the trial balance the figures are transposed and written as P21,570. The
resulting error amounted to P180 and is divisible by 9. Another common error is the
slide, or incorrect placement of the decimal point, as when P21,750.00 is copied as
P2,175.00. The resulting discrepancy in the trial balance will also be an amount divisible
by 9. Assume that the office equipment account has a debit balance of P42,000 but it is
erroneously listed in the credit column of the trial balance, This will cause a discrepancy
of two times P42,000 or P84,000 in the trial balance totals. Since such errors as
recording a debit in a credit column are common, it is advisable, after determining the
discrepancy in the trial balance totals, to scan the columns for an amount equal to
exactly one-half of the discrepancy. It is also advisable to look over the transactions for
an item of the exact amount of the discrepancy, An error may have been made by
recording the debit side of the transaction and forgetting to enter the credit side.
3. Compare the accounts and amounts in the trial balance with that in the ledger. Be
certain that no account is omitted,
4. Recompute the balance of each ledger account.
5. Trace all postings from the journal to the ledger accounts. As this is done, place a check
mark in the journal and in the ledger after each figure is verified. When the operation is
completed, look through the journal and the ledger for unchecked amounts. In tracing
postings, be alert not only for errors in amount but also for debits entered as credits, or
vice versa.
Note that even when a trial balance is in balance, the accounting records may still contain
errors. A balanced trial balance simply proves that, as recorded, debits equal credits. The
following errors are not detected by a trial balance:
1. Failure to record or post a transaction,

2. Recording the same transaction more than once.
3. Recording an entry but with the same erroneous debit and credit amounts.
4. Posting a part of a transaction correctly as a debit or credit but to the wrong account.
Chapter Exercises
Problem 1# Journal Entry, T-Account and Trial Balance
Remedios Palaganas is an experienced events planner. The transactions and accounts

for the business are as follows:
May 1 Invested P100,000 in cash to start her own business,

May 5 Paid P5,000 for one month's rent.
May 6 Bought office furniture for P15,000 in cash.
May 7 Performed services for P12,000 in cash.
May 8 Performed services for P10,800 on credit.
May 11 Acquired a fax machine for P7,500; paid P3,000 in cash, balance due in 10 days.
May 13 Received P5,400 from clients on account.
May 15 Paid P10,000 for salaries.
May 16 Settled in full the P4,500 balance for the fax machine.
May 17 Received P7,000 in cash for services performed
May 20 Performed services for P12,000 on credit.
May 28 Paid P1,350 for the monthly telephone bill.
May 28 Paid P2,400 for the electric and water bills.
May 29 Collected P2,000 from clients on account,
May 30 Palaganas withdrew P7,000 in cash for personal expenses.
Required:
1. Use the following accounts: Cash; Accounts Receivable; Office Furniture; Office
Equipment; Accounts Payable; Palaganas, Capital; Palaganas, Withdrawals; Consulting
Revenues; Salaries Expense; Rent Expense; Utilities Expense.
Problem #2 Journal Entry, T-Account and Trial Balance
Jay Omotoy opened a plumbing service, Alabang Plumbing. Operations began on Apr; 1,
2021, and the following transactions were completed during the month:
Apr. 1 Withdrew P67,000 from a personal savings account and used it to open a new account
in the name of Alabang Plumbing.
Apr 2 Acquired a service vehicle costing P81,000. A payment of P17,500 in cash was made and
a note payable given for the P63,500 remainder.
Apr 3 Paid rent for the month, P7,150.
Apr 6 Acquired plumbing supplies on account of P15,700.
Apr 7 Paid for three months of advertising and recorded Prepaid Advertising in the amount of
P6,000.
Apr 8 Cash in the amount of P18,350 was received for plumbing services rendered.
Apr 9 Acquired additional plumbing supplies for cash, P8,050.
Apr 11 Paid salaries, P11,600.
Apr 15 Rendered plumbing services and billed the customer, P42,200.
Apr 16 Paid P5,700 of the amount owed from the transaction of Apr. 6.
Apr 19 Paid miscellaneous expenses, P4,300
Apr 20 Collected P21,000 from the customer on the Apr. 15 transaction.
Apr 21 Withdrew P14,500 from the business.
Apr 22 Paid salaries, P14,100.
Apr 24 Paid the first installment of the note payable, P3,850.
Apr 25 Paid telephone expense, P1,250.
Apr 27 Billed the Clement Resort for plumbing services rendered, P14,150.
Use the following accounts: Cash; Accounts Receivable; Plumbing Supplies; Prepaid
Advertising; Service Vehicle; Notes Payable; Accounts Payable; Omotoy, Capital; Omotoy,
Withdrawals; Plumbing Revenues; Salaries Expense; Rent Expense; Telephone Expense; and
Miscellaneous Expense.
.
Chapter 4: Adjusting The Accounts
1. Explain accrual accounting and state how it improves financial statements.

2. Explain the importance of periodic reporting and time period assumption.
3. Explain the recognition and derecognition process.
4. Identify the types of adjustments and their purposes.
5. Illustrate how accounting adjustments link to financial statements.
6. Use the same steps learned in analyzing transactions.
7. Prepare and explain the adjusting entries.
8. Interpret the effects of omitting adjustments on the financial statements.
9. Develop skills in preparing and adjusting entries using T-Accounts.
10. Summarize the adjustment process showing the type of adjustment, the effect of omitting
the adjusting entry on the financial statements and the adjusting entry.
11. Prepare an adjusted trial balance.
12. Explain the alternative methods of recording deferrals,
ACCRUAL BASIS
The financial statements, except for the cash flow statement, are prepared on the accrual basis
of accounting in order to meet their objectives. Under the accrual basis, the effects of
transactions and other events are recognized when they occur and not as cash is received or
paid. This means that the accountant records revenues as they are earned and expenses
as they are incurred. The timing of cash flows is relatively immaterial for determining when to
recognize revenues and expenses.
Financial statements prepared on the accrual basis inform users not only of past transactions
involving the payment and receipt of cash, but also of obligations to pay cash in the future, and
of resources that represent cash to be received in the future. Generally accepted accounting
principles require that a business use the accrual basis.
In cash basis accounting, however, the accountant does not record a transaction until cash is
received or paid. Generally, cash receipts are treated as revenues and cash payments as
expenses. Cash basis income is the difference between operating cash receipts and
disbursements. These cash flows necessarily exclude investments by and distributions to the
owner in the computation of income.
Illustration. A client paid the Sea Wind Resort in Boracay Island P7,000 on April 8, 2020 for a
one-day super deluxe accommodation on May 13, 2020. Under accrual basis of accounting, the
receipt of P7,000 will be considered as revenues when the business has rendered its services
on May 13.
In contrast, if a cash basis is used, the hotel will recognize revenues on April 8. Expenses
related to this revenue transaction will be incurred on May 13. Suppose a financial report is
prepared at the end of April, under accrual basis, no revenue or expense will be reported; under
cash basis, revenues of P7,000 will be reported but the related expenses will be recognized
when incurred on May 13. Observe that the accrual basis provided a better measure of the
results of transactions.
PERIODICITY CONCEPT
The only way to know how successfully a business has operated is to close its doors, sell all its
assets, pay the liabilities and return any excess cash to the owners. This process of going out of
business is called liquidation. This, however, is not a practical way of measuring business
performance.
Accounting information is valued when it is communicated early enough to be used for

economic decision-making. To provide timely information, accountants have divided the
economic life of a business into artificial time periods. This assumption is referred to as the
periodicity concept.
Accounting periods are generally a month, a quarter or a year. The most basic accounting
period is one year. Entities differ in their choice of the accounting year- fiscal, calendar or
natural. A fiscal year is a period of any twelve consecutive months. A calendar year is an annual
period ending on December 31. A natural business year is a twelve-month period that ends
when business activities are at their lowest level of the annual cycle. A period of less than a
year is an interim period. Some even adopt an annual reporting period of 52 weeks.
Businesses need periodic reports to assess their financial condition and performance. The
periodicity concept ensures that accounting information is reported at regular intervals. It
interacts with the recognition and derecognition principles to underlie the use of accruals. To
measure profit in a fair manner, entities update the income and expense accounts immediately
before the end of the period.
RECOGNITION AND DERECOGNITION
Per 2018 Conceptual Framework, recognition is the process of capturing for inclusion in the
statement of financial position or the statement(s) of financial performance an item that meets
the definition of an asset, a liability, equity, income or expenses.
The amount at which an asset, a liability or equity is recognized in the statement of financial
position is referred to as its "carrying amount". The statement of financial position and
statement(s) of financial performance depict an entity's recognized assets, liabilities, equity,
income and expenses in structured summaries that are designed to make financial information
comparable and understandable.
Recognition links the elements, the statement of financial position and the statement(s) of
financial performance. The statements are linked because the recognition of one item (or a
change in its carrying amount) requires the recognition or derecognition of one or more other
items (or changes in the carrying amount of one or more other items).
For example:
(a) the recognition of income occurs at the same time as:
● the initial recognition of an asset, or an increase in the carrying amount of an asset; or
● the derecognition of a liability, or a decrease in the carrying amount of a liability.
(b) the recognition of expenses occurs at the same time as:
● the initial recognition of a liability, or an increase in the carrying amount of a liability; or
● the derecognition of an asset, or a decrease in the carrying amount of an asset.
The initial recognition of assets or liabilities arising from transactions or other events may result
in the simultaneous recognition of both income and related expenses. For example, the sale of
goods for cash results in the recognition of both income (from the recognition of one asset-~the
cash) and an expense (from the derecognition of another asset~the goods sold). The
simultaneous recognition of income and related expenses is sometimes referred to as the
matching of costs with income.
Recognition is appropriate if it results in both relevant information about assets, liabilities, equity,
income and expenses and a faithful representation of those items, because the aim is to provide
information that is useful to investors, lenders and other creditors.
Derecognition is the removal of all or part of a recognized asset or liability from an entity's
statement of financial position. Derecognition normally occurs when that item no longer meets
the definition of an asset or of a liability:
(a) for an asset, derecognition normally, occurs when the entity loses control of all or part of the
recognized asset; and
(b) for a liability, derecognition normally occurs when the entity no longer has a present
obligation for all or part of the recognized liability.
THE NEED FOR ADJUSTMENTS
Accountants make adjusting entries to reflect in the accounts information on economic activities
that have occurred but have not yet been recorded. Adjusting entries assign revenues to the
period in which they are earned, and expenses to the period in which they are incurred. These
entries are needed to properly measure the profit for the period, and to bring related asset and
liability accounts to correct balances for the financial statements.
In short, adjustments are needed to ensure that the recognition and derecognition
principles are followed thus resulting in financial statements reporting the effects of all
transactions at the end of the period.
Adjusting entries involve changing account balances at the end of the period from what is the
current balance of the account to what is the correct balance for proper financial reporting.
Without adjusting entries, financial statements may not fairly show the solvency of the entity in
the balance sheet and the profitability in the income statement.
DEFERRALS AND ACCRUALS
Accountants use adjusting entries to apply accrual accounting to transactions that cover more
than one accounting period. There are two general types of adjustments made at the end of the
accounting period--deferrals and-accruals.
Each adjusting entry affects a balance sheet account (an asset or a liability account) and an
income statement account (income or expense account). Deferral is the postponement of the
recognition of "an expense already paid but not yet incurred," or of "revenue already
collected but not yet earned". This adjustment deals with an amount already recorded in a
balance sheet account; the entry, in effect, decreases the balance sheet account and increases
an income statement account.
Deferrals would be needed in two cases:

1. Allocating assets to expense to reflect expenses incurred during the accounting period
(e.g. prepaid insurance, supplies and depreciation).
2. Allocating revenues received in advance to revenue to reflect revenues earned during
the accounting period (e.g. subscriptions).
Accrual is the recognition of "an expense already incurred but unpaid", or "revenue earned
but uncollected". This adjustment deals with an amount unrecorded in any account; the entry,
in effect, increases both a balance sheet and an income statement account.
Accruals would be required in two cases:

1. Accruing expenses to reflect expenses incurred during the accounting period that are
unpaid and unrecorded.
2. Accruing revenues to reflect revenues earned during the accounting period that are
uncollected and unrecorded.
ADJUSTMENTS FOR DEFERRALS (Step 5)
Allocating Assets to Expenses
Entities often make expenditures that benefit more than one period. These expenditures are
generally debited to an asset account. At the end of each accounting period, the estimated
amount that has expired during the period or that has benefited the period is transferred from
the asset account to an expense account. Two of the more important kinds of adjustments
are prepaid expenses, and depreciation of property and equipment.
Prepaid Expenses
Some expenses are customarily paid in advance. These expenditures (e.g. supplies, rent and
insurance) are called prepaid expenses. Prepaid expenses are assets, not expenses. At the end
of an accounting period, a portion or all of these prepayments may have expired. The portion of
an asset that has expired becomes an expense. Prepaid expenses expire either with the
passage of time or through use and consumption. The flow of costs from the balance sheet to
the income statement is illustrated below:
If adjustments for prepaid expenses are not made at the end of the period, both the balance
sheet and the income statement will be misstated. First, the assets of the entity will be
overstated; second, the expenses of the company will be understated. For this reason, the
owner's equity in the balance sheet and profit in the income statement will both be overstated.
Besides prepaid rent, Weddings. "R" Us has prepaid expenses for supplies and insurance, both
accounts need adjusting entries.
Prepaid Rent (Adj a). On May 1, Weddings "R" Us paid P8,000 for two months' rent in
advance. This expenditure resulted in an asset consisting of the right to occupy the office for two
months. A portion of the asset expires and becomes an expense each day. By May 31, one-half
of the asset had expired, and should be treated as an expense.
The analysis of this economic event is shown below:
Transaction Expiration of one month's rent.
Rules Decreases in assets are recorded by credits. Decreases in owner's equity

are recorded by debits.
Entry Decrease in owner's equity is recorded by a debit to rent expense.

Decrease in assets is recorded by a credit to prepaid rent.
Dr. Cr.
Rent Expense (OE:E) 4,000
Prepaid Rent (A) 4,000
Prepaid Insurance (Adj. b). Weddings "R" Us acquired a one-year comprehensive insurance
coverage on the service vehicle and paid P14,400 premiums. In a manner similar to prepaid
rent, prepaid insurance offers protection that expires daily. The adjustment is analyzed and
recorded as shown below:
Transaction Expiration of one month's insurance.
Analysis Assets decreased: Owner's equity decreased.

Entry Decrease in owner's equity is recorded by a debit to insurance expense;

decrease in assets as a credit to prepaid insurance.
Dr. Cr.
InsuranceExpense (OE:E) 1,200
Prepaid Insurance (A) 1,200
The prepaid insurance account has a balance of P13,200 (May 4 prepayment of P14,400 less
P1,200) and insurance expense reflects the expired cost of P1,200 for the month. As a matter of
company policy, the period May 4 to 31 is considered a month.
Supplies (Adj c). On May 8, Weddings "R" Us purchased supplies, P18,000, During the month,
the entity used supplies in the process of performing services for clients. There is no need to
account for these supplies every day since the financial statements will not be prepared until the
end of the month. At the end of the accounting period, Besario makes a careful physical
inventory of the supplies. The inventory count showed that supplies costing P15,000 are still on
hand.
This transaction is analyzed and recorded as follows:

Transaction Consumption of supplies.

are recorded by debits
Entry Decrease in owner's equity is recorded by a debit to supplies expense.

Decrease in assets is recorded by a credit to supplies.
Dr. Cr.
SuppliesExpense (OE:E) 3,000
Supplies (A) 3,000
The asset account supplies now reflect the adjusted amount of P15,000 (P18,000 less P3,000).
In addition, the amount of supplies expensed during the accounting period is reflected as
P3,000.
Depreciation of Property and Equipment
When an entity acquires long-lived assets such as buildings, service vehicles, computers or
office furniture, it is basically buying or prepaying for the usefulness of that asset. These assets
help generate income for the entity. Therefore, a portion of the cost of the assets should be
reported as expense in each accounting period. Proper accounting requires the allocation of the
cost of the asset over its estimated useful life. The estimated amount allocated to any one
accounting period is called depreciation of depreciation expense. Three factors are involved in
computing depreciation expense:
1. Asset cost is the amount an entity paid to acquire the depreciable asset.
2. Estimated salvage value is the amount that the asset can probably be sold for at the end
of its estimated useful life.
3. Estimated useful life is the estimated number of periods that an entity can make use of
the asset. Useful life is an estimate, not an exact measurement.
Accountants estimate periodic depreciation. They have developed a number of methods for
estimating depreciation. The simplest procedure is called the straight-line method. The formula
for determining the amount of depreciation expense for each period using this method is:
Asset cost xxx

Less: Estimated salvage value -xxx
Depreciable cost =xxx
Divided by: Estimated useful life /xxx
Depreciation Expense for each time period =xxx
The asset account is not directly reduced when recording depreciation expense. Instead, the
reduction is recorded in a contra account called accumulated depreciation, A contra account
is used to record reductions in a related account and its normal balance is opposite that of the
related account.
Use of the contra account- accumulated depreciation -allows the disclosure of the original cost
of the related asset in the balance sheet. The balance of the contra account is deducted from
the cost to obtain the book value of the property and equipment.
Service Vehicle and Office Equipment (Adj. d and e). Suppose that Weddings "R" Us
estimated that the service vehicle (P420,000), which was bought on May 4, will last for seven
years (eighty-four months) and with a salvage value of P84,000. The office equipment
(P60,000) that was acquired on May 5 will have a useful life of five years (sixty months) and
will be worthless at that time.
Substitution of the pertinent amounts into the basic formula will yield depreciation for service
vehicle and office equipment for the month as P4,000 (P420,000 - P84,000)/84 months] and
P1,000 (P60,000/60 months), respectively. These amounts represent the cost allocated to the
month, thus reducing the asset accounts and increasing the expense accounts. As a matter of
company policy, the period May 4 to 31 is considered a month. The analysis follows:
Transaction Recording depreciation expense.

Entry Owner's equity is decreased by debits to depreciation expense- service

vehicle and depreciation expense-office equipment.
Assets are decreased by credits to contra-asset accounts accumulated
depreciation-service vehicle and accumulated depreciation-office
equipment.
Dr. Cr.
Depreciation Expense-Service Vehicle (OE:E) 4,000
Accumulated Depreciation-Serv. Vehicle (A) 4,000
Depreciation Expense-Office Equipt. (OE:E) 1,000
Accumulated Depreciation-Off. Equipt. (A) 1,000
Allocating Revenues Received in Advance to Revenues

There are times when an entity receives cash for services or goods even before service is
rendered or goods are delivered. When such is received in advance, the entity has an obligation
to perform services or deliver goods. The liability referred to is unearned revenues.
For example, publishing companies usually receive payments for magazine subscriptions in
advance. These payments must be recorded in a liability account. If the company fails to deliver
the magazines for the subscription period, subscribers are entitled to a refund. As the company
delivers each issue of the magazine, it earns a part of the advance payments. This earned
portion must be transferred from the unearned subscription revenues account to the
subscription revenues account.
Unearned Referral Revenues (Adj. f). On May 15, Weddings *R* Us received P10,000 as an
advance payment for referrals made. Assume that by the end of the month, one of the three
couples referred has already taken their marriage vows and as a result the amount of P4,000
pertaining to the referred event has been realized. This transaction is analyzed as follows:
Transaction Recognition of income where cash is received in advance.
Analysis Liabilities decreased. Owner's equity increased
Rules Decreases in liabilities are recorded by debits. Increases in

owner's equity are recorded by credits
Entry Decrease in liabilities is recorded by a debit to unearned referral revenues,

Increase in owner's equity is recorded by a credit to referral revenues.
Dr. Cr.
Unearned Referral Revenue (L) 4,000
Referral Revenue (OE:I) 4,000
ADJUSTMENTS FOR ACCRUALS (Step 5)
Accrued Expenses
An entity often incurs expenses before paying for them. Cash payments are usually made at
regular intervals of time such as weekly, monthly, quarterly or annually. If the accounting period
ends on a date that does not coincide with the scheduled cash payment date, an adjusting entry
is needed to reflect the expense incurred since the last payment. This adjustment helps the
entity avoid the impractical preparation of hourly or daily journal entries just to accrue expenses.
Salaries, interest, utilities (e.g., electricity, telecommunications and water) and taxes are
examples of expenses that are incurred before payment is made.
Accrued Salaries (Ad. g). Entities pay their employees at regular intervals. It can be weekly,
semi-monthly or monthly. Weekly payrolls are usually made on Fridays (for a five-day
workweek) or Saturdays (for a six-day workweek). Weddings "R" Us pays salaries every two
Saturdays. Assume that the calendar for May appears as follows:
The office assistant and the account executive were paid salaries on May 13 and 27. At
month-end, the employees have worked for three days (May 29, 30 and 31) beyond the last pay
period. The employees have earned the salary for these days, but it is not due to be paid until
the regular payday in April. The salary for these three days is rightfully an expense for May, and
the liabilities should reflect that the entity owes the employees salaries for those days.
Each of the employee's salary rate is P7,800 per month or P300 per day (P7,800/26 working
days). The expense to be accrued is P1,800 (P300 x 3 days × 2 employees). This accrued
expense can be analyzed as shown:
Transaction Accrual of unrecorded expense
Analysis Liabilities increased. Owner's equity decreased.
Rules Increases in liabilities are recorded by credits. Decreases in owner's equity

Entry Decrease in owner's equity is recorded by a debit to salaries expense.

Increase in liabilities is recorded by a credit to salaries payable.
Dr. Cr.
Salaries Expense (OE:E) 1,800
Salaries Payable (L) 1,800
The liability of P1,800 is now correctly reflected in the salaries payable account. The actual
expense incurred for salaries during the month is P15,600.
Accrued Interest (Adj. h). On May 2, Besario borrowed P210,000 from Metrobank. She issued
a promissory note that carried a 20% interest per annum. Both the interest and principal will be
payable in one year. The note issued to the bank accrues interest at 20% annually. At the end of
May, Besario owed the bank P3,500 (see computation below) for interest in addition to the
P210,000 loan.
Interest is a charge for the use of money over time.Interest expense is matched to a particular
period during which the benefit-the use of borrowed money--is received. The interest is a fixed
obligation and accrues regardless of the results of the entity's operations.
Interest rates are expressed at annual rates, so if interest is being calculated for less than a
year, the calculation must express time as a portion of a year. Thus, the interest expense
(simple) incurred on this note during the month is determined by the following formula:
Interest = Principal Interest Rate x Length of Time

= P210,000 × 20% per year × 1/12 of a year
= P210,000 x .20 × 1/12
= P3,500
The adjusting entry to reword the interest expense incurred in May is as follows:
Transaction Accrual of unrecorded expense.
Analysis Liabilities increased. Owner's equity decreased.
Rules Increases in liabilities are recorded by credits. Decreases in the owner's

equity are recorded by debits.
Entry Decrease in owner's equity is recorded by a debit to interest expense;

increase in liabilities as credit to interest payable.
Dr. Cr.
Interest Expense (OE:E) 3,500
Interest Payable (L) 3,500
Accrued Revenues
An entity may provide services during the period that are neither paid for by clients nor billed at
the end of the period. The value of these services represents revenue earned by the entity. Any
revenue that has been earned but not recorded during the accounting period calls for an
adjusting entry that debits an asset account and credits an income account.
Accrued Consulting Revenues (Adj. i). Suppose that Weddings "R" Us agreed to arrange a
rush but simple civil wedding for a madly-in-love couple in the afternoon of May 31. The entity
intended to charge fees of P5,300 for the services, which is earned but unbilled. This should be
recorded as shown below:
Transaction Accrual of unrecorded revenue
Analysis Assets increased. Owner's equity increased.
Rules Increases in assets are recorded by debits. Increases in owner's

equity are recorded by credits.
Entry Increase in assets is recorded by a debit to accounts receivable.

Increase in owner's equity as a credit to consulting revenues.
Dr. Cr.
Consulting Revenues (OE:) 5,300
A total of P67,700 in consulting revenues was earned by the entity during the month. The
Weddings "R* Us illustration did not tackle entries related to uncollectible accounts. Hence, the
ensuing discussion on the accrual of uncollectible accounts is not in any way related to the
Weddings "R" Us illustration. This is to complete the illustrations on adjustments for accruals.
SUMMARY OF ADJUSTING ENTRIES

Chapter 5: Worksheet and Financial Statements

1. Describe the flow of accounting information from the unadjusted trial balance into the
adjusted trial balance and finally, into the income statement and balance sheet columns of the
worksheet.
2. Prepare accurately and in good form a ten-column worksheet.
3. Understand and appreciate the usefulness of financial statements.
4. Develop skills in the preparation of financial statements.
5. Explain how the financial statements are interrelated.
THE WORKSHEET
Accountants often use a worksheet to help transfer data from the unadjusted trial balance to the
financial statements. This multi-column document provides an efficient way to summarize the
data for financial statements. The accountant generally prepares a worksheet when it is time to
adjust the accounts and prepare financial statements.
Note, however, that it is possible to prepare financial statements directly from the adjusted trial
balance at the end of the accounting period if the business has relatively few accounts. The
worksheet simplifies the adjusting and closing process. It can also reveal errors. The worksheet
is not part of the ledger or the journal, nor is it a financial statement. It is a summary device used
by the accountant for his convenience. The basic structure of the worksheet is presented in
Exhibit 5-1.
PREPARING THE WORKSHEET (Step 5)

The steps in the preparation of a worksheet will be illustrated using the Weddings "R" Us case:
1. Enter the account balances in the unadjusted trial balance columns and total the amounts.
2. Enter the adjusting entries in the adjustments columns and total the amounts.
3. Compute each account's adjusted balance by combining the unadjusted trial balance and the
adjustment figures. Enter the adjusted amounts in the adjusted trial balance columns.
The trial balance debit or credit amount of each account is combined with the amount of any
debit or credit adjustment to that account to determine the new balance of the account. This
process is known as cross-footing.
4. Extend the asset, liability and owner's equity amounts from the adjusted trial balance columns
to the balance sheet columns. Extend the income and expense amounts to the income
statement columns. Total the statement columns.
5. Compute profit or loss as the difference between total revenues and total expenses in the
income statement. Enter profit or loss as a balancing amount in the income statement and in the
balance sheet, and compute the final column totals.
Profit or loss is equal to the difference between the debit and credit columns of the income
statement.
ESSENCE OF FINANCIAL STATEMENTS
Per March 2018 Conceptual Framework for Financial Reporting (2018 Conceptual Framework),
the objective of financial statements is to provides financial information about the reporting
entity's assets, liabilities, equity, income and expenses that is useful to users of financial
statements in assessing the prospects for future net cash inflows to the reporting entity and in
assessing management's stewardship of the entity's economic resources.
COMPLETE SET OF FINANCIAL STATEMENTS
Per revised PAS No. 1, a complete set of financial statements comprises:

1. A statement of financial position as at the end of the period;
2. A statement of financial performance for the period;
3. A statement of changes in equity for the period;
4. A statement of cash flows for the period;
5. Notes, comprising a summary of significant accounting policies and other explanatory
information; and
6. A statement of financial position as at the beginning of the earliest comparative period when
an entity applies an accounting policy retrospectively or makes a retrospective restatement of
items in its financial statements or when it reclassifies items in its financial statements.
In a nutshell, the statement of financial position (or balance sheet) lists all the assets,
liabilities and equity of an entity as at a specific date. The statement of financial performance
(or income statement) presents a summary of the revenues and expenses of an entity for a
specific period. The statement of changes in equity presents a summary of the changes in
capital such as investments, profit or loss, and withdrawals during a specific period. The
statement of cash flows reports the amount of cash received and disbursed during the period.
Accounting policies are the specific principles, bases, conventions, rules and practices adopted
by an enterprise in preparing and presenting financial statements. Notes to financial
statements provide narrative descriptions or disaggregation of items presented in the
statements and information about items that do not qualify for recognition in the statements.
PREPARING THE FINANCIAL STATEMENTS (Step 6)

Once the worksheet is completed, it is easy to prepare the financial statements for the account
balances that have been extended to the appropriate income statement and balance sheet
columns. Most of the information needed to prepare the income statement, statement of
changes in equity and balance sheet are available from the worksheet.
The statements presented are those of Weddings "R" Us. Note that financial statements shall be
presented at least annually (per revised PAS No. 1).
Statement of Financial Performance

An entity can present all items of income and expense recognized in a period: in a single
statement of comprehensive income, or in two statements: a statement displaying components
of profit or loss (separate income statement) and a second statement beginning with profit or
loss and displaying components of other comprehensive income. However, the 2018
Conceptual Framework does not specify whether the statements) of financial performance
comprises) a single statement or two statements.
The income statement is a statement showing the performance of the enterprise for a given
period of time. It summarizes the revenues earned and expenses incurred for that period of
time. The income statement for Weddings "R" Us (refer to Exhibit 5-5) is prepared directly from
the income statement columns of the worksheet in Exhibit 5-4
Statement of Changes in Equity
The statement of changes in equity summarizes the changes that occurred in owner's equity.
This statement is now a required statement (per revised Philippine Accounting Standards (PAS)
No. 1). Changes in an enterprise's equity between two balance sheet dates reflect the increase
or decrease in its net assets during the period.
In the case of sole proprietorships, increases in owner's equity arise from additional investments
by the owner and profit during the period. Decreases result from withdrawals by the owner and
from loss for the period. The beginning balance and additional investments are taken from the
owner's capital account in the general ledger.
The profit or loss figure comes directly from the income statement while the withdrawals from
the balance sheet columns in the worksheet.
Statement of Financial Position
The statement of financial position is a statement that shows the financial position or condition
of an entity by listing the assets, liabilities and owner's equity as at a specific date. The
information needed for this statement are the net balances at the end of the period, rather than
the total for the period as in the income statement. This statement is also called the balance
sheet.
Users of financial statements analyze the balance sheet to evaluate an entity's liquidity, its
financial flexibility, and its ability to generate profits, and its solvency. Liquidity refers to the
availability of cash in the near future after taking account of the financial commitments over this
period. Financial flexibility is the ability to take effective actions to alter the amounts and
timings of cash flows so that it can respond to unexpected needs and opportunities. This
includes the ability to raise new capital or tap into unused lines of credit. Solvency refers to the
availability of cash over the longer term to meet financial commitments as they fall due.
In preparing the balance sheet, it may not be necessary to make any further analysis of the
data. The needed data--that is, the balances of the asset, liability, and owner's equity
accounts--are already available from the balance sheet columns of the worksheet. However, the
interim balance for owner's equity must be revised to include profit or loss and owner's
withdrawals for the accounting period. The adjusted amount for ending owner's equity is shown
in the statement of changes in equity.
Format
The balance sheet can be presented in either the report format or the account format.
The report format simply;lists the assets, followed by the liabilities then by the owner's equity in
vertical sequence. The account format lists the assets on the left and the liabilities and owner's
equity on the right. Either balance sheet format is acceptable.
Classification
The revised PAS No. 1 does not prescribe the order or format in which an entity presents items
in the statement of financial position; what is required is the current and non-current distinction
for assets and liabilities. Assets can be presented current then non-current, or vice versa.
Liabilities and equity can be presented current liabilities then non-current liabilities then equity,
or vice versa,
It is proper to present a classified balance sheet; that is, the assets and liabilities are separated
into various categories. Assets are sub-classified as current assets and non-current assets;
while liabilities as current liabilities and non-current liabilities. At this point, it is advisable to
review the definitions of the foregoing (refer to Chapter 2).
Classifying a balance sheet aids in the analysis of financial statement data. When a
presentation based on liquidity provides accounting information that is reliable and more
relevant to decision-makers then an entity shall present all assets and liabilities in order of
liquidity.
For example, Assets are classified and presented in decreasing order of liquidity. Cash is the
most liquid. Assets that are least likely to be converted to cash are listed last. Liabilities are
generally classified and presented based on time of maturity such that obligations which are
currently due are listed first.
It can be observed in Exhibit 5-7 that the total assets of P546,700 in the balance sheet does not
tally with the total debits of P565,700 in the balance sheet columns of the worksheet in Exhibit
5-4. Likewise, the total liabilities and owner's equity do not equál the total credits in the same
exhibit.
The reason for these differences is that accumulated depreciation and withdrawals are
subtracted from their related accounts in the balance sheet but added in their respective
columns in the worksheet.
The classified balance sheet of Weddings "R" Us in report format is:
Statement of Cash Flows

The statement of cash flows provides information about the cash receipts and cash payments of
an entity during a period. It is a formal statement that classifies cash receipts (inflows) and cash
payments (outflows) into operating, investing and financing activities. This statement shows the
net increase or decrease in cash during the period and the cash balance at the end of the
period; it also helps project the future net cash flows of the entity.
The discussion below gives an overview of some important concepts involved in the preparation
of the cash flow statement.
Cash Flows from Operating Activities

Operating activities generally involve providing services, and producing and delivering goods.
Cash flows from operating activities are generally the cash effècts of transactions and other
events that enter into the determination of profit or loss. This cash flow can be presented using
either the direct or the indirect method.
Using the direct method, the entity's net cash provided by (used in) operating activities is
obtained by adding the individual operating cash inflows and When subtracting the individual
operating cash outflows.
The indirect method derives the net cash provided by (used in) operating activities by adjusting
profit for income and expense items not resulting from cash transactions. The adjustment
begins with profit followed by the addition of expenses and charges (e.g. depreciation) that did
not entail cash payments. Then, increases in current assets and decreases in current liabilities
involved in the determination of profit but which did not actually increase or decrease cash, are
subtracted from profit. Finally, decreases in current assets and increases in current liabilities are
added to profit to obtain net cash provided by (used in) operating activities.
Profit P xxx
Adjustments for:
Non-Cash Expenses (e.g. Depreciation) xx
Increases in Current Asset Accounts (xx)
Decreases in Current Liability Accounts (xx)
Decreases in Current Asset Accounts xx
Increases in Current Liability Accounts xx
Cash Flows from Operating Activities P xxx
For example, increases in accounts receivable from sale of services or goods represented an
increase in profit without the corresponding increase in cash--for it is still a receivable. Since
these revenues are already included in the computation of profit, the increase in accounts
receivable should be deducted from the profit figure. To illustrate further, assume that salaries
payable increased. Increases in salaries payable meant that the entity did not pay the full
amount of salaries expense for the period.
Cash inflows
● receipts from sale of goods and performance of services
● receipts from royalties, fees, commissions and other revenues
Cash Outflows
● payments to suppliers of goods and services
● payments to employees/ payments for taxes
● payments for interest expense
● payments for other operating expenses
Cash Flows from Investing Activities

Investing activities include making and collecting loans; acquiring and disposing of investments
in debt or equity securities; and obtaining and selling of property and equipment and other
productive assets.
Cash Inflows
● receipts from sale of property and equipment
● receipts from sale of investments in debt or equity securities
● receipts from collections on notes receivable
Cash Outflows
● payments to acquire property and equipment
● payments to acquire debt or equity securities
● payments to make loans to others generally in the form of notes receivable
Cash Flows from Financing Activities

Financing activities include obtaining resources from owners and creditors.
Cash Inflows
● receipts from investments by owners
● receipts from issuance of notes payable
Cash Outflows
● payments to owners in the form of withdrawals
● payments to settle notes payable
RELATIONSHIPS AMONG THE FINANCIAL STATEMENTS
The financial statements are based on the same underlying data and are fundamentally related.
The following shows the basic interrelationships among the financial statements:
1. The income statement reports all income and expenses during the period. The profit or loss is
the final figure in this statement.
2. The statement of changes in equity considers the profit or loss figure from the income
statement as one of the determining factors that explains the change in owner's equity.
3. The statement of financial position reports the ending owner's equity, taken directly from the
statement of changes in equity.
4. The statement of cash flows reports the net increase or decrease in cash during the period
and ends with the cash balance reported in the balance sheet. This statement is prepared
based on information from the income statement and the balance sheet.
Chapter 6: Completing the Accounting Cycle

1. Explain why temporary accounts are closed each period.
2. Recognize the need for a post-closing trial balance and reversing entries in particular
instances.
3. Prepare and post adjusting entries, closing entries and reversing entries.
4. Prepare a post-closing trial balance.
ADJUSTMENTS ARE JOURNALIZED AND POSTED (Step 7)

The adjustment process is a key element of accrual basis accounting. The worksheet helps in
the identification of the accounts that need adjustments. The adjusting entries are directly
entered in the worksheet.
Most accountants prepare the financial statements immediately after completing the worksheet.
The adjustments are journalized and posted as the closing entries are made. This step in the
accounting cycle brings the ledger into agreement with the data reported in the financial
statements.
CLOSING ENTRIES ARE JOURNALIZED AND POSTED (Step 8)
Income, expense and withdrawal accounts, are temporary accounts that accumulate information
related to a specific accounting period. These temporary accounts facilitate income statement
preparation. At the end of each year, the balances of these temporary accounts are transferred
to the capital account. Thus, the balance of the owner's capital account represents the
cumulative net result of income, expense, and withdrawal transactions. This phase of the cycle
is called the closing procedure.
A temporary account is said to be closed when an entry is made such that its balance becomes
zero. Closing simply transfers the balance of one account to another account.
In this case, the balances of the temporary accounts are transferred to the capital account. A
summary account- Income Summary is used to close the income and expense accounts. The
steps in closing the accounts of an entity will be illustrated using the Weddings "R" Us case.
1. Close the income accounts
Income accounts have credit balances before the closing entries are posted. For this reason, an
entry debiting each revenue account in the amount of its balance is needed to close the
account. The credit is made to the income summary account.
The entry to close the income accounts for the Weddings "R" Us is as follows:
The dual effect of the entry is to make the balances of the income accounts equal to zero, and
to transfer the balances in total to the credit side of the income summary account. Note that the
data for closing the income accounts can be found in the credit side of the income statement
columns of the worksheet in Exhibit 5-4.
2. Close the expense accounts
Expense accounts have debit balances before the closing entries are posted. For this reason, a
compound entry is needed crediting each expense account for its balance and debiting the
income, summary for the total. These data can be found in the debit side of the income
statement columns of the worksheet.
The effect of posting the closing entry is to reduce the expense account balances to zero and to
transfer the total of the account balances to the debit side of the income summary account.
3. Close the income summary account
After posting the closing entries involving the income and expense accounts, the balance of the
income summary account will be equal to the profit or loss for the period. A profit is indicated by
a credit balance and a loss by a debit balance. The income summary account, regardless of the
nature of its balance, must be closed to the capital account. For the Weddings "R" Us, the entry
is as follows:
The effect of posting this closing entry is to close the income summary account balance and to
transfer the balance to Besario's capital account for the profit.
4. Close the withdrawal account

The withdrawal account shows the amount by which capital is reduced during the period by
withdrawals of cash or other assets of the business by the owner for personal use. For this
reason, the debit balance of the withdrawal account must be closed to the capital account as
follows:
The effect of posting this closing entry is to close the withdrawal account and to transfer the
balance to the capital account.
PREPARATION OF A POST-CLOSING TRIAL BALANCE (Step 9)

It is possible to commit an error in posting the adjustments and closing entries to the ledger
accounts; thus, it is necessary to test the equality of the accounts by preparing a new trial
balance. This final trial balance is called a post-closing trial balance.
The post-closing trial balance verifies that all the debits equal the credits in the trial balance.
The trial balance contains only balance sheet items such as assets, liabilities, and ending
capital because all income and expense accounts, as well as the withdrawal account, have zero
balances.
Notice that only the balance sheet accounts have balances because at this point, all the income
statement accounts have been closed
REVERSING ENTRIES (Step 10)
Preparing the post-closing trial balance may not be the last step in the accounting cycle.
Some entities elect to reverse certain end-of-period adjustments on the first day of the new
period. A reversing entry is a journal entry which is the exact opposite of a related adjusting
entry made at the end of the period. It is basically a bookkeeping technique made to simplify the
recording of regular transactions in the next accounting period.
It should be emphasized that reversing entries are optional. Also, the act of reversing a
previously recorded adjusting entry should not lead us to the conclusion that the entries
reversed are unnecessary or inaccurate. Even when an entity follows the policy of making
reversing entries, not all adjusting entries should be reversed.
Generally, a reversing entry should be made for any adjusting entry that increases an asset or a
liability account. Therefore, all accruals are reversed but only deferrals initially recorded in
income statement--income or expense-accounts are reversed.
Using the summary of adjusting entries in Chapter 4, the veracity of the general rule stated in
the previous paragraph can be proven. For example, in the case of a prepaid expense initially
recorded in an expense account, the adjusting entry debited an asset-prepaid expense. An
asset increased; hence, applying the general rule, this adjustment. can be reversed.
After analyzing the rest of the adjusting entries, the adjustments that can be reversed are as
follows: prepaid expenses (expense method), unearned revenues (income method), accrued
expenses and accrued revenues.
Illustration. To show how reversing entries can be helpful, consider the adjusting entry made in
the records of Weddings "R" Us to accrue salaries expense:
These transactions had the following effects on salaries expense:
a. Adjusted salaries expense to accrue P1,800 in the proper accounting period.
b. Closed the P15,600 in total salaries expense for May to income summary.
Established a credit balance of P1,800 on June 1 in salaries expense equal to the expense
recognized through the adjusting entry on May 31. The liability account salaries payable was
reduced to a zero balance.
D. Recorded the P7,200 payment of two weeks' salaries in the usual manner. The reversing
entry has the effect of leaving a balance of P5,400 (P7,200 - P1,800) in the salaries expense
account. This P5,400 balance represented the salaries expense for the nine workdays in June.
DISCUSSION QUESTIONS
1. Why are closing entries made at the end of the accounting period?
2. Income and expense accounts also called temporary accounts are closed at the end of each
accounting period. Why is this so?
3. Closing entries are necessary to accomplish four important tasks. Enumerate these
tasks.
4. How does a post-closing trial balance differ from the trial balance prepared before adjusting
entries are made?
5. What is a reversing entry? Enumerate the four adjustments that can be reversed at the
beginning of the next accounting period.
SOURCE BOOK:
Basic Financial Accounting and Reporting 2021 Edition by Prof. WIN Ballada

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ACC 223: Basic Accounting

Chapter 1: Accounting and Its Environment

After studying this chapter, you should be able to:

1. Define accounting and explain its role in business.

Accounting is an information system that measures, processes and communicates financial

Development of more formal account-keeping methods is attributed to the merchants and

Double-entry bookkeeping is not a discovery of science; it is the outcome of continued efforts to

Amatino Manucci was the inventor of double-entry bookkeeping. He managed to construct a

The Method of Venice

Savary and Napoleonic Commercial Code

Schmalenbach and The Model Chart of Accounts

FUNDAMENTAL BUSINESS MODEL

The business model is built on five activities:

Type Activity Structure Examples

Services Selling people’s time Hiring Skilled staff Software

Trader Buying and selling Buying a range of Wholesaler

Manufacture Designing products, Taking raw materials Vehicle Assembly

Raw materials Growing or extracting Buying blocks of land Farming

Infrastructure Selling the utilization Buying and operating Transport (airport,

Financial Receiving deposits, Accepting cash from Bank

Insurance Pooling premiums of Collecting cash from Insurance

FORMS OF BUSINESS ORGANIZATIONS

Corporation. A corporation is a business owned by its stockholders. It is an artificial being

MICRO, SMALL AND MEDIUM ENTERPRISES (MSMEs)

ACTIVITIES IN BUSINESS ORGANIZATIONS

PURPOSE AND PHASES OF ACCOUNTING

PACIOLI’S DOUBLE ENTRY BOOKKEEPING AND ITS EVOLUTION

1. It provides an accurate record of what has happened to a business over a specified

● What profit has the business made?

This results to the development of two main specialization in accounting:

Entity Concept - each entity should be evaluated separately

GENERAL ACCEPTANCE OF AN ACCOUNTING PRINCIPLE (GAAP) - encompass

Revenue Recognition Principle - Revenue is to be recognized in the accounting period when

Expense Recognition Principle - Expenses should be recognized in the accounting period in

1. Why is accounting often referred to as the language of business?

After studying this chapter, you should be able to:

1. Describe the parts of an information system.

PARTS OF AN INFORMATION SYSTEM

ACCOUNTING INFORMATION SYSTEM

An effective accounting information system should achieve the following objectives:

Computer-Based Transaction System maintains accounting data separately from other

ELEMENTS OF FINANCIAL STATEMENTS

Element Description or Definition

Asset A present economic resource controlled by the entry as a result of past

Liability A present obligation of the entity to transfer an economic resource as a

Income Increase in assets, or decreases in liabilities, that result in increase in

Expenses Decrease in assets, or increases in liabilities, that result in decrease in

The basic accounting model is:

ASSETS = LIABILITIES + OWNER’S EQUITY

DEBITS AND CREDITS – THE DOUBLE-ENTRY SYSTEM

Normal balances in Balance Sheet

Left Side or Debit Side Right Side or Credit Side

Increases (+) Decreases (-)

Left Side or Debit Side Right Side or Credit Side

Decreases (-) Increases (+)

Left Side or Debit Side Right Side or Credit Side

Decreases (-) Increases (+)

Normal balances in Income Statement

Left Side or Debit Side Right Side or Credit Side

Increases (+) Decreases (-)

Left Side or Debit Side Right Side or Credit Side

Decreases (-) Increases (+)

ACCOUNTING EVENTS AND TRANSACTIONS